Before The Bell
The U.S. stock and bond markets continue to look toward Corporate America and the business beat for direction. That was certainly the case yesterday, as a disappointing report on private-sector job creation from Automatic Data Processing (ADP) brought some worries on Wall Street about the pace of the U.S. economic recovery, despite a solid report on nonmanufacturing activity from the Institute for Supply Management. The big miss in private sector payrolls (less than half the expectation at 330,000) pushed investors away from the economically sensitive sectors and into the big technology names with their steady growth profiles and strong balance sheets, as well as the more-defensive stocks. (The healthcare and utilities issues have performed well over the last month of trading after a lackluster first-half showing, owing to their defensive attributes.) Whether this proves to be more of a one-off event or the start of a trend may depend on the forthcoming July employment and unemployment figures.
The ADP report, which is the precursor to the government’s report on nonfarm payrolls (due tomorrow at 8:30 A.M. EDT), but often not a strong indicator of what the report from the Labor Department will show, did bring some concerns that the U.S. economy may be starting to slow and prompted some rotation out of the cyclical stocks and into the technology issues that performed well during the pandemic. The tech-heavy NASDAQ Composite bucked the selling yesterday, finishing 19 points to the upside. The Dow Jones Industrial Average, though, declined nearly 325 points, hurt by its energy components, which fell on weaker oil prices, owing to economic concerns. Likewise, the Dow Transports Index, whose performance is highly correlated to the state of the U.S. economy, dropped more than 2%, and bond yields retreated. The yield on the benchmark 10-year Treasury note fell to 1.13%, which was right near its six-month low. This is an important technical level because if it is broken to the downside, it could signal that Wall Street believes that the pace of U.S. economic growth may slow in the latter part of this year and in 2022.
This morning, the attention remains on earnings and the business beat. At 8:30 A.M. EDT, we learned that initial weekly jobless claims came in at 385,000, which was a 14,000 improvement from the previous week, and continuing claims fell below the 3 million mark. The equity futures, which were signaling some bargain hunting after yesterday’s selling, are holding most of those gains following the labor report.
Wall Street also is working through a number of quarterly earnings reports, which, at first blush, have made for a mixed reading. Of note, some of the companies that were pandemic winners, including streaming services Roku (ROKU) and online marketplace center ETSY, Inc. (ETSY), are looking at lower openings today for their stocks, despite both companies posting solid quarterly results. Investors did not like seeing some slippage in those companies’ key operating metrics, hurt by more people resuming pre-pandemic activities. Conversely, the stocks of the many of the companies that stand to benefit from the continued reopening of the U.S. economy and more people getting the COVID-19 vaccines have fared well during the second-quarter reporting season. The quarterly reports from the retailers over the next few weeks may provide more color on the reopening trade.
So what is an investor to do with the major equity averages sitting just off record highs and many stocks looking priced for perfection? The first thing we recommend is maintaining a healthy level of equities in one’s portfolio. But with signs of late indicating that the ongoing economic recovery may now be in mid-cycle (the aforementioned recent contraction in Treasury yields would seem to suggest such), it may be a good opportunity for some rotation out of the leveraged (namely stocks with high price-to-earnings ratios)—stocks that benefited from the Federal Reserve pumping unprecedented amounts of liquidity into the financial system to combat the ill effects of the coronavirus pandemic on the U.S. economy and into some of the high-quality names. (It is worth noting that the month of August has historically been a difficult month for stocks and the S&P 500 Index has not witnessed a 5% correction since last fall.) Those stocks ranked 1 (Highest) or 2 (Above Average) for Safety by The Value Line Investment Survey should be given a closer look. Value Line’s stock screening capabilities and model portfolios can make identifying these high-quality stocks quite simple.
– William G. Ferguson
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
